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Mutual Funds and Mutual Fund Investing - Fidelity Investments

FICS Editors' Note

Every investment comes with its own particular set of risks. Do your research or consult a financial adviser before deciding if any of the choices below are right for you.

Demystifying bond ETFs

If you want the benefits of bonds, bond ETFs may be worth a look.

Fidelity Active Investor

–
01/18/2019

Bond ETFs

Investing strategies

Markets

Bond ETFs

Bonds

Corporate bonds

Exchange traded funds

Fixed income

High-yield bonds

Municipal bond funds

Mutual funds

Taxable bond funds

Treasury bonds

iShares ETFs

Investing strategies

Markets

Bond ETFs

Bonds

Corporate bonds

Exchange traded funds

Fixed income

High-yield bonds

Municipal bond funds

Mutual funds

Taxable bond funds

Treasury bonds

iShares ETFs

Investing strategies

Markets

Bond ETFs

Bonds

Corporate bonds

Exchange traded funds

Fixed income

High-yield bonds

Municipal bond funds

Mutual funds

Taxable bond funds

Treasury bonds

iShares ETFs

Investing strategies

Markets

Bond ETFs

Bonds

Corporate bonds

Exchange traded funds

Fixed income

High-yield bonds

Municipal bond funds

Mutual funds

Taxable bond funds

Treasury bonds

iShares ETFs

Investing strategies

Markets

Bond ETFs

Bonds

Corporate bonds

Exchange traded funds

Fixed income

High-yield bonds

Municipal bond funds

Mutual funds

Taxable bond funds

Treasury bonds

iShares ETFs

If you are looking for income, diversification, and exposure to a specific asset class, bonds can play an important role in your investment portfolio. When looking at the bond universe, individual bonds, bond mutual funds, and bond exchange-traded funds (ETFs) offer ways to obtain the benefits of fixed income.

The latter of these investments has been popular; bond ETFs attracted $55 billion, $84 billion, $123 billion, and $98 billion in net flows the last 4 years, respectively.1

Here are a few key things to know about bond ETFs—and some ETFs to consider.

The big bond world

When it comes to the bond market, you have a lot of choices. It can be a daunting task to assemble and maintain an appropriately diversified portfolio of individual bonds, given the size and diversity of the more than $100 trillion bond universe.2

Buying bonds in the past was more complicated, as the bond market used to be more opaque and fragmented. Today, with visibility into recent trades, depth of available inventory, and access to most of the available secondary market offerings, you are able to get a better snapshot of a bond’s value and its liquidity than ever before.

In addition, bond mutual funds and bond ETFs are often a low-cost way to buy a diversified basket of bonds, even if you have a relatively small amount of money to invest. For a detailed comparison of the features of bonds, bond mutual funds, and bond ETFs, see the table.

None if bought at par value and held to maturity without default. Bonds can be purchased and sold in the secondary market prior to maturity at a profit or loss.

Principal or par value of the bond returned at maturity, subject to the creditworthiness of the issuer. Secondary market sale can result in a profit or loss and day-to-day values will fluctuate.

Brokerage fees may apply. No fee or charge for new-issue bonds, Treasuries, CDs, and munis. If not held to maturity, transaction cost (bid/ask) will be impacted by position size. There are costs for transacting in the secondary market.

The minimum is generally $1,000 to $5,000, depending on the type of bond. To be diversified, you will need to buy a basket of bonds.

Bond mutual funds

Regular fund distributions, though amounts vary depending on the underlying bond holdings of the fund.

Potential for capital appreciation and loss.

Most bond funds do not have a maturity date, so principal will fluctuate. Most funds can be bought and sold daily.

Mutual funds charge a fee represented by the expense ratio, which reflects operating expenses as a percentage of the fund’s average net asset, as well as any transaction or load fees.

Most funds have a $2,500 to $10,000 minimum investment. Bond funds are portfolios of bonds, which can offer broad diversification, depending on the fund’s investment objective.

Bond ETFs

Regular fund distributions, though amounts vary depending on the underlying holdings of the fund.

Potential for capital appreciation and loss.

ETFs can be bought and sold intraday on an exchange. Most ETFs do not have a maturity date, so principal will fluctuate.

Net expense ratios are comparable to similar mutual funds, and trading fees depend on product and platform. ETFs may trade at a premium or discount to net asset value (NAV), and are subject to a bid/ask spread.

No minimum investment required. Bond ETFs are portfolios of bonds, which can offer broad diversification, depending on the fund’s investment objective. Some are narrowly focused.

Bond funds up close

While bond mutual funds have been around longer, bond ETFs are growing in popularity. Since the first US-listed bond ETF was launched in 2002, bond ETFs have accumulated over $652 billion in assets—although that is still a fraction of the roughly $3.8 trillion bond mutual fund market.3

Bond ETFs are similar to bond mutual funds in that both hold a basket of individual bonds and are professionally managed, either passively (the fund attempts to mirror the performance of a bond index or benchmark) or actively (the fund attempts to outperform a bond index or benchmark). To date, most bond ETFs are passively managed.

Both bond mutual funds and bond ETFs can provide exposure to a variety of markets, sectors, maturities, and credit qualities.

Their tax treatment is similar too. When it comes to individual bonds, you generally pay income taxes on interest received at ordinary income rates, unless the bond is tax-exempt, but you don’t pay capital gains taxes unless you sell the bond before maturity at a profit. With a bond ETF or fund, you will likely pay both income taxes on interest paid when you sell units of a fund, typically through a monthly dividend (e.g., a fund distribution), and capital gains if they are paid out, typically through an annual dividend (e.g., a fund distribution).

However, there are some differences. Whereas a bond mutual fund’s price is set at the end-of-day market price, a bond ETF is bought or sold at the intraday market price, which may be different than the ETF's net asset value (NAV).4

Bond mutual funds generally provide holdings disclosures monthly and discourage short-term trading of fund shares. In comparison, bond ETFs are required to disclose their holdings daily to support daily exchange trading activity. Depending on distribution models and to control short-term trading, bond mutual funds may be subject to redemption or transaction fees; bond ETFs are not. Instead, bond ETFs are subject to bid-ask spreads and brokerage commissions or fees.

“Bond ETFs might be most appropriate for those fixed income investors who like the advantages of ETFs, including intraday trading and holdings transparency,” explains Lee Sterne, ETF strategist with Fidelity. “Bond ETFs let you tactically pick and choose when you want to enter and exit the market, based on prevailing market conditions.”

Bond ETF risks

Of course, just as bond ETFs provide certain advantages, they also have risks. Bond ETFs have risks similar to individual bonds and bond mutual funds, such as maturity, interest rate, and credit risk. Bond ETFs also have tracking risk (a measure of risk that is due to active management decisions made by the portfolio manager), and their potential valuation may be at a premium or discount to NAV.

Additionally, some bond ETFs may not have a long enough track record to analyze how they might react to different market conditions and phases of the business cycle.

Abundance of bond ETF opportunities

You should decide for yourself whether bond ETFs, bond mutual funds, or individual bonds are right for you. Or a combination of these different types of products might be suitable, depending on your specific investing objectives, risk constraints, and time horizon. Whatever route you choose, a strong case for active bond management can be made in today's market, given the size and complexity of the bond universe.

If you are interested in exploring bond ETFs, check out the list of the largest bond ETFs by NAV within 8 bond fund categories. Additionally, Fidelity offers 5 other bond ETFs that are available for purchase on Fidelity.com commission-free: Fidelity Total Bond ETF (FBND), Fidelity Corporate Bond ETF (FCOR), Fidelity Limited Term Bond ETF (FLTB), Fidelity High Yield Factor ETF (FDHY), and Fidelity Low Duration Bond Factor ETF (FLDR).

Largest bond ETFs by NAV among a variety of categories

Broad market bond ETFs

iShares Core US Aggregate
Bond ETF (AGG)*

Vanguard Total
Bond Market ETF (BND)

Schwab US Aggregate
Bond ETF (SCHZ)

US government bond ETFs

iShares Short Treasury Bond ETF (SHV)*

iShares 1-3 Year Treasury
Bond ETF (SHY)*

iShares 7-10 Year Treasury
Bond ETF (IEF)*

Global total bond

Vanguard Total International Bond ETF (BNDX)

iShares Intermediate-Term Corporate Bond ETF (IGIB)*

iShares Core International Aggregate
Bond ETF (IAGG)*

High yield bond ETFs

iShares iBoxx $ High Yield Corporate Bond ETF (HYG)*

SPDR Barclays High Yield
Bond ETF (JNK)

SPDR Barclays Capital Short Term High Yield
Bond ETF (SJNK)

US corporate bond ETFs

iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD)*

Vanguard Short-Term Corporate Bond ETF (VCSH)

Vanguard Intermediate-Term Corporate Bond ETF (VCIT)

US municipal bond ETFs

iShares National AMT-Free Muni Bond ETF (MUB)*

Vanguard Tax-Exempt Bond Index ETF (VTEB)

SPDR Barclays Short Term Municipal Bond (SHM)

US inflation-projected
bond ETFs

iShares Tips Bond ETF (TIP)*

Vanguard Short-Term Inflation-Protected Securities ETF (VTIP)

Schwab US TIPS ETF (SCHP)

*Available for purchase commission-free on Fidelity.com. Source: Fidelity Investments, as of January 13, 2019.

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What Fidelity Offers

Free commission offer applies to online purchases of Fidelity ETFs and select iShares ETFs in a Fidelity brokerage account. The sale of ETFs is subject to an activity assessment fee (from $0.01 to $0.03 per $1,000 of principal).

ETFs are subject to market fluctuation and the risks of their underlying investments. ETFs are subject to management fees and other expenses. Unlike mutual funds, ETF shares are bought and sold at market price, which may be higher or lower than their NAV, and are not individually redeemed from the fund.

1. Source: BlackRock, as of January 13, 2019.

2. Source: Bank of International Settlements, as of January 13, 2019.

3. Source: Fidelity Investments, as of January 13, 2019

4. NAV equals a fund's assets less its liabilities, divided by the total shares outstanding.

For iShares ETFs, Fidelity receives compensation from the ETF sponsor and/or its affiliates in connection with an exclusive, long-term marketing program that includes promotion of iShares ETFs and inclusion of iShares funds in certain FBS platforms and investment programs. Additional information about the sources, amounts, and terms of compensation is described in the ETF’s prospectus and related documents. Fidelity may add or waive commissions on ETFs without prior notice. BlackRock and iShares are registered trademarks of BlackRock, Inc. and its affiliates.

Any screenshots, charts, or company trading symbols mentioned are provided for illustrative purposes only and should not be considered an offer to sell, a solicitation of an offer to buy, or a recommendation for the security.

The views expressed are as of the date indicated and may change based on market or other conditions. Unless otherwise noted, the opinions provided are those of the speaker or author, as applicable, and not necessarily those of Fidelity Investments. The experts are not employed by Fidelity but may receive compensation from Fidelity for their services.

Past performance is no guarantee of future results.

Diversification and asset allocation do not ensure a profit or guarantee against loss.

In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible. Any fixed income security sold or redeemed prior to maturity may be subject to loss.

Interest rate increases can cause the price of a debt security to decrease. Increase in real interest rates can cause the price of inflation-protected debt securities to decrease. Interest payments on inflation-protected debt securities can be unpredictable.

<In addition, nondiversified funds that focus on a relatively small number of issuers tend to be more volatile than diversified funds and the market as a whole.>

<The yield quoted for the Inflation-Protected Bond Fund is before adjustment due to the rate of inflation. The actual yield will be a combination of this yield and an inflation adjustment.>

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Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.

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